Do Political Budget Cycles Differ in Latin American Democracies?

The literature on political business cycles has produced important insights on the extent to which politicians attempt to manipulate government monetary and fiscal policies to influence electoral outcomes. In particular, some of the strongest evidence produced to date suggests that electoral cycles are particularly marked in the case of government expenditures.¹ Governments in developing countries and so-called new democracies are often considered to be the most susceptible to the manipulation of fiscal and monetary policy to enhance their chances of reelection.² The experiences of recently reestablished Latin American democracies in a period marked by episodes of heightened macroeconomic volatility followed by the adoption of painful stabilization measures provide fertile ground for testing political budget cycle theories and recently formulated arguments on the acuteness of these patterns for young fragile democratic regimes in developing countries.

The case of Argentina is illustrative of the expected trajectory in Latin American countries. Following the return of democracy in 1983, the Alfonsín and Menem administrations spent an average of 12.94 percent of GDP and collected an average of 10.67 percent of GDP in tax revenue. During this early period of democracy, fiscal deficits averaged 2.28 percent of GDP. Budget deficits worsened to an average of 2.98 percent in an election year. The rise in the deficit was driven by the decrease in tax collection, which fell by 6.3 percent as spending only rose by 0.003 percent. Fiscal balances improved after Fernando de la Rua assumed the presidency in 1999, with an average fiscal deficit of 1.20 percent of GDP between 2000 and 2008. Additionally, fiscal balances did not deteriorate during elections, but rather improved slightly. When Néstor Carlos Kirchner was elected president in 2003, Argentina ran a slight fiscal surplus of 0.12 percent.

This paper seeks to verify whether these patterns hold systematically for Latin America by exploring two questions. First, are elections catalysts for fiscal policy performance in Latin America? Second, are electoral competitions more likely to provoke larger increases in fiscal deficits during democratic transitions? To answer these questions robustly, we test for political deficit cycles in Latin American democracies employing different measures of democracy, transitions, and election cycles. Our results confirm that elections provoke increases in the fiscal deficit for Latin American democracies, but this pattern is not contingent on a country being in the early phase of its democratic transition. This highlights the importance of the selection criteria used to define democracy and competitive elections when testing for political budget cycles.

The paper is structured in the following way. The next section reviews existing theory on the behavior of democracies with respect to government spending, revenue collection, and budget deficits, as well as findings that might clarify why competitive elections held in Latin America during transitional democratic periods may prove to be particularly important and distinct. The paper then describes the time-series cross-sectional data set employed for hypothesis testing and introduces the measures used to test the impact of elections in all Latin American democracies and whether cycles differ when a democratic regime is in a transitional stage. In this section, we also discuss different measures for democracy and recent democratization and the importance of using these measures to undertake more robust testing of the findings reported in earlier studies on political budget cycles in recent democracies. The next section introduces the model specifications used for hypothesis testing in this paper and the battery of alternative models adopted to check the findings for robustness. We then present and discuss the results of the empirical analysis. The final section concludes the paper with a summary of the key findings.

Review of the Literature

A crucial assumption of political business cycle models is that voters choose leaders on the basis of economic variables, so the degree, nature, and timing of economic policies influence citizens' decisions at the ballot box. The electoral motivations that may guide government policies were discussed by Schumpeter in his study of business cycles and described by Kalecki, but the theoretical framework...